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Prospects Weekly: Concerns about global economic prospects amid loss of confidence

Global Macroeconomics Team's picture
Concerns about global economic prospects amid heightened financial market turmoil are weighing on consumer spending despite the relief coming from lower commodity prices. Associated uncertainty is reflected in a sharp decline of gross capital flows to developing countries in Q3, with bond and equity flows having plunged as investors sought safe-haven assets. The impact of these forces on developing-country markets have intensified recently. Since mid-September, credit-default swaps on the sovereign debt of developing countries have increased a further 62.6 basis points as of October 5th, bringing the median increase since July 31st to 122 basis points (developing country sovereign debt yields are up 84 basis points over the same period). Reflecting these same forces, exchange rates in most developing countries depreciated markedly in September (ING reports that investors pulled $3.2 billion out of emerging-market debt funds in the week ending Sept. 28).
Consumer spending growth in high-income countries remains weak amid the financial crisis. Overall retail sales in high-income countries advanced at a meager annualized pace of 0.7% in the three months ending August, as consumers in the United States and the Euro area refrained from increasing spending. Disappointing real disposable income growth has weighed on consumer spending in the U.S, which was flat in August. A 0.3% fall in retail sales volumes in the Euro Area (-2.9% in Germany) seems more tied to falling confidence. A more dynamic consumer sector in developing countries (10.8% y/y) supported global retail sales growth of 4% year-on-year in August. In contrast to weak spending by consumers, investment spending has remained relatively robust despite disappointing business surveys. This is especially so in the United States, where strong investment demand and foreign trade point to a modest acceleration in growth in Q3.


Gross capital flows to developing countries slowed sharply in Q3-2011, amid volatile global conditions. Gross capital flows in Q3-2011 were 64% lower than in Q3-2009 and 52% lower than in Q3-2010. Bond and equity flows were particularly weak during August and September due to uncertainties about the outcome of the European debt crisis. However, the recent slump is less pronounced than following the Lehman crisis of 2008, when almost no bonds were issued or IPOs launched. So far bank lending has held relatively steady, supported by several mega deals in India, Mexico, and Russia. Year-to-date syndicated bank loans stand 41% above last year’s level with the Europe and Central Asia region accounting for much of the increase. In addition, H1 data suggest that FDI in developing countries will be stronger this year than in 2010.


In recent weeks, the currencies of most developing economies have depreciated against the U.S. dollar and against other major trading partners. The declines reflect global investors’ mounting risk aversion and flight to safety, which led to a falloff in capital inflows to developing countries and rising CDS spreads. Between October 5th and September 1st, many developing-country currencies lost 10% or more of their value vis-à-vis the U.S. dollar. Taking into account cross-exchange rate movements and using the average level of exchange rates in September versus August, the extent of depreciations were less pronounced. The yen and the U.S. dollar were among the currencies that appreciated markedly. Importantly the renminbi appreciated against both the U.S. dollar and the rest of the world. So far this year it has appreciated at a 5.1% and 3.9% annualized pace versus the U.S. dollar and major trading partners, respectively.


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